Q2 2022 Encompass Health Corp Earnings Call
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Good morning, everyone and welcome to encompass Health's second quarter 2022 earnings Conference call.
At this time I would like to inform all participants that third lines will be in a listen only mode.
After the speakers remarks, there will be a question and answer period.
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I will now turn the call over to Mark Miller encompass Health's, Chief Investor Relations Officer.
Thank you operator, and good morning, everyone. Thank you for joining encompass health second quarter 2022 earnings call.
With me on the call today.
Mark Tarr, President and Chief Executive Officer, Doug Coltharp, Chief Financial Officer, and Patrick Darby General Counsel and corporate Secretary.
Before we begin if you do not already have a copy the second quarter earnings release supplemental information and related form 8-K filed with the SEC are available on our website at encompass health Dot com.
On page two of the supplemental information you will find the safe Harbor statements, which are also set forth in greater detail on the last page of the earnings release during the call. We will make forward looking statements, which are subject to risks and uncertainties many of which are beyond our control certain risks and uncertainty.
He's like those relating to the spinoff of inhabit Inc, and its impact on our business and stockholder value as well as the magnitude and impact of COVID-19 that could cause actual results to differ materially from our projections estimates and expectations are discussed in the company's SEC filings.
Including the earnings release and related form 8-K, the Form 10-K for year ended December 31, 2021, and the Form 10-Q for the quarter ended June 30, 2022 one file we encourage you to read them.
You are cautioned not to place undue reliance on the estimates projections guidance and other forward looking information presented which are based on current estimates of future events and speak only as of today, we do not undertake a duty to update these forward looking statements.
Our supplemental information on discussion on this call will include certain non-GAAP financial measures for such measures reconciliations to the most directly comparable GAAP measure is available at the end of the supplemental information at the end of the earnings release and as part of the form 8-K filed yesterday with the.
SEC all of which are available on our website.
I would like to remind everyone that we will adhere to the one question and one follow up question rule to allow everyone to submit a question. If you have any additional questions. Please feel free to put yourself back in the queue with that I'll turn the call over to Mark Tarr Mark. Thank you and good morning, everyone. The strategic review of encompass.
As home health and hospice business culminated in the spin off of inhabit on July one to be an independent publicly traded company.
And haven't reported its Q2 results yesterday after the market close and has its earnings call. Following this call. Accordingly, we will not be commenting on it habits Q2 results.
Q2 was another solid quarter for our inpatient rehabilitation business.
Demand for services continues to grow.
Our value proposition is resonating across payers and we are gaining share in what remains an underserved market.
Our de Novo Embed addition strategies are increasing availability of the highly specialized services, we provide to meet this rising demand.
Our commitment of substantial capital to these capacity expansions underscores our confidence in the future prospects of the business.
We opened three de novo's in Q2, making that six year to date.
We will open three more de novo's in the second half of 2022, bringing the total to nine openings for the year.
We expect a similar number of openings in 2023.
We added 38 beds to existing hospitals in the quarter raising the year to date total to 67.
We expect to add a total of approximately 90 beds to existing hospitals in 2022, an additional 100 to 150 beds and 2023.
Our total discharges grew four 9% in the quarter and one 6% on a same store basis. This was on top of 18, 7% total discharge growth and 16.9% growth on a same store basis in Q2 2000.
'twenty, one resulting in an impressive two year kicker.
As has been the case for the past several quarters. The continued strong demand for our services in a tight labor market for skilled clinicians necessitated elevated utilization of agency staffing and sign on and shift bonuses.
As we had foreshadowed on our Q1 call. We did see sequential improvement in contract labor cost during Q2 with both the number of contracts labor Ftes and the negotiated rates declining.
Consistent with our Q1 comments, we chose to redeploy a portion of the contract labor savings into sign on and shift bonuses for our internal S. T E.
Contract labor plus sign on and shift bonuses totaled $56 $9 million in Q2 compared to $63 million in Q1, and $28 7 million in Q2 2021.
Our Q2 agency rate per FTE was approximately $222000 compared to approximately $240000 in Q1 of 2022.
We have responded to the challenging labor market conditions for skilled clinical resources in a number of ways.
<unk>, adding substantial resources to our talent acquisition team.
We have built a centralized recruitment function now comprising over 60 professionals.
This strategy is gaining headway.
Same store net new or in hires were 276 for the first half of 2022 as compared to 117 in the same period last year.
For the second half of 2022, we expect sign on and shift bonuses to remain elevated as we continue to hire more our ends and use existing staff to fill in gaps.
This will facilitate a decrease in our utilization of contract labor.
Assuming normalizing industry conditions, we expect agency rates decline further.
However, the pace of the decline remains uncertain as agency rates remained highly variable and the extension of the public health emergency may prolong the duration of elevated rates.
Yeah.
CMS last week issued the 2023 final rule.
For <unk> the final rule will implement a net market basket update of three 9%.
We estimate that taken as a whole the final rule will result in a net increase of approximately 4% for our Medicare payments beginning October one 2022.
As a reminder, this increase does not include the impact of sequestration.
All the rate update in the Earth rule is positive relative to current reimbursement rates. It does not adequately compensate for our elevated operating costs.
On the regulatory front on July 1st CMS sent a report to Congress on a prototype for a unified post acute care perspective payment system or Pac P. P. S. As required by the impact Act of 2014.
CMS did not make legislative recommendations to Congress as to why should happen with the prototype and caution that substantially more analysis and research are required.
For these and other reasons it is too early to elevate or evaluate any potential impacts to our business from the pack P. P. S.
On July 20th we announced that our board of directors declared a quarterly dividend of <unk> 15 per share to be paid in October .
The decline from our recent historical rate as in response to the completion of the spin off of and habits and reflects our continued commitment to a robust de Novo hospital strategy.
We are affirming our guidance issued on June seven for 2022 Earth revenue adjusted EBITDA and adjusted EPS.
The key considerations underlying this guidance can be found on page 18 of the supplemental slides.
With that I'll turn it over to Doug.
Thank you Mark and good morning, everyone.
In Q2, our <unk> business generated revenues of approximately 1.63 billion and adjusted EBITDA of $96 4 million.
Adjusted free cash flow was $166 8 million with year to date adjusted free cash flow of $290 million up approximately 21% over the first six months of 2021.
The key trends, we experienced the last several quarters largely continued in the second quarter of 2022.
As Mark discussed we continue to see good volume growth the combined with a modest one 3% increase in revenue per discharge to produce our six 1% revenue growth in the quarter.
As has been the case for the past several quarters staffing challenges did not limit volume growth, but did result in the continuation of elevated cost.
The Q2 contract labor plus sign on and shift bonuses of $56 9 million that Mark alluded to was comprised of 30 $35 1 million in contract labor and $21 8 million in sign on and shipped bonuses.
Contract Labor expense in Q2 declined approximately $6 $8 million or 16% from Q1, and we experienced sequential declines in contract labor expense and Ftes for every month in Q2.
Contract Labor Ftes, which had peaked at 749 in March declined to 597 in June a 20% decline.
Contract Labor rates also declined during the quarter.
The Q2 2022 agency rate per FTE was approximately $222000 as compared to approximately $245000 in Q1.
Rates also declined sequentially every month in Q2.
Agency rates peaked at approximately $243 3000 in February and declined 40% to approximately 293000 in June .
Revenue reserves related to bad debt increased 50 basis points to two 2% primarily due to the impact of payer mix shifts to Medicare advantage and managed care, which have longer collection times and higher patient payment responsibility.
Medicare contractors have also recently resumed the targeted probe and educated initiative for <unk> providers.
The resumption of TBE adds additional uncertainty to our near term bad debt reserve requirements.
As a result within our reaffirmed 2020 guidance, we are increasing our expected revenue reserves related to bad debt from 2% to a range of two to two 2%.
I would also like to point out that Earth year to date free cash flow is $290 million and our full year 2022 expectation is for a range of $280 million to $380 million.
The large difference between first half and second half free cash flow relates to cash tax payments changes in working capital and capital expenditures, which are skewed to the second half of the year.
And with that we'll now open the line for questions.
Okay.
Thank you.
If you would like to ask a question. Please press star one on your telephone keypad.
You will be limited to one question and one follow up question.
Our first question will come from Andrew Mok with UBS.
Good morning, Andrew Andrew.
Hi, good morning.
I know you held the full year guidance, but just wanted to better understand how the quarter tracked against internal expectation and then I think there is still a meaningful ramp in earnings in the back half of the year is there anything that you would call out besides labor as driving that sequential improvement.
Yes, so I would say that.
And I think it's evidenced in the fact that we're affirming our guidance that second quarter was very much in line with our expectations pretty much across the board.
Think of the puts in terms of the puts and takes that are going to drive improved results in the second half of the year on the positive side, we expect continued year over year discharge growth.
You've got the swing in the new store impact, which was a significant drag on EBITDA in the first quarter and turns modestly part or in the first half and turns model modestly positive in the second half.
We've got the pricing increase that will be implemented in Q4, and then the continuation of improving labor costs, given the trend lines that I've just outlined in my comments.
Weighing against that are the full implementation of sequestration, which began on July one.
And then the anticipated increase or the uncertainty around the bad debt reserve.
Andrew I would suggest that those are the primary considerations.
Got it that's helpful. And then a lot of hospital operators are now forecasting lower inpatient demand in the back half of 2022, I just wanted to better understand what you're seeing in the market and weather.
Any of that slowing inpatient utilization is having downstream impacts to your discharge growth. Thanks.
Hi, It is mark we've not seen a negative impact I think that given our ability to have the growth that we did in the second quarter, particularly compared against the very.
Difficult prior year comp I think if anything we've seen.
And more of the marketplaces are resuming to from our acute care standpoint kind of resuming to more a normalized business pattern with referral patterns.
Similar to 2019 versus the last couple of years with Covid certainly electric procedures has come back into place nicely as well. So we're not really seeing anything that we would see that would impact negatively in the second half of the year.
Great. Thanks for the color.
Thank you. Our next question will come from Kevin Fischbeck with Bank of America.
Good morning, Kevin.
Hey, good morning, actually this is Joe and I got here filling in for Kevin Joanne I'm sort of thinking that Christian salary yet.
So I guess on the contract language. So first the follow up and then a question about the follow up on the contract labor use that yes.
We will continue to decline.
So do you expect.
At this level.
But all the way back to the 2019 or you think you know as you exit the year, it's still going to be continued to be elevated how should we think structurally about you know it is the <unk>.
Mato changing here or alright.
Should we assume that that does skew the normalization into next year.
I don't think anybody really knows the answer to that Joanna Theres certainly a lot of uncertainty about it we do see as we pointed out in providing some very tangible evidence we do see that those based on market conditions and the proactive steps that we've been taking to address staffing that the utilization and the cost of contract labor is improving.
I don't believe that we'll get back to 2019 levels by the time that we exit 2022.
How long it takes to get back to those levels, assuming that we ever do remains to be seen but we do expect continued sequential improvement through the back half of the year.
As we noted the net new R&D hires a 2276 for the first half versus the 117 in prior year.
That shows the progress that we're making right now with our ability to hire nurses, which plays very favorable.
The contract Labor reduction story and bear in mind that $2, 76% same store. So on top of that we were able to recruit sufficient nursing.
Staff too.
To address all of our new hospital openings in the first half.
Yes, because actually that was my second question because it sounds like you keep opening and you can start getting more.
Both been notebook, but also additional bad so it sounds like there now where they are.
Major issues in terms of staffing booth, new beds or new.
Building.
The way to think about it.
That's correct staffing constraints have not impacted the timing with which we are bringing new capacity on board and as we referenced in our remarks, nor have staffing constraints in any way limited our volume as a whole.
We've been <unk> been very pleased with the new de Novo hospitals in the new markets, we're entering with with the receptivity of the staff towards having a new hospital in and in some cases, a rehabilitation environment that did not previously exist.
We did experience some modest delays in bringing on a couple of the de novo's and that was 100% attributable to actually constraints within the agencies that are required to provide approvals on our state and local basis and they were experiencing some of their own staffing shortages, but nothing on our end was.
Delaying the opening of new capacity.
Yeah.
Great. Thank you so much.
Thank you.
Our next question will come from Brian <unk> with Jefferies Hey.
Hey, Brian Good morning, Brian .
Good morning I.
I guess just to follow up on the questions on contract labor. So maybe Doug as I think about the sign ownership bonuses that you paid I mean, it kind of flattened out from Q4 to Q2.
How should we be thinking about that trend for the back half of the year and into next year.
Yeah, we would expect that to improve from the current run rate as well, but at a much more modest level than than contract labor.
So I really don't have an opportunity for you really don't have an opportunity much there for rate reduction and it's really just then about the volume that you're utilizing and we think it's a pretty good trade right now to increase that number of a net RN hires.
Got it Okay, and then maybe mark as I think about.
The inpatient rehab growth target that you set out 6% to 8% discharge CAGR through 2026 without the noise. The habit in the background, maybe just any thoughts on how you're thinking about makeup of that I know, you're obviously already a lot of de Novo <unk> JV, just maybe any color on.
How to get to that 6% to 8% over the next four years.
I mean, we're very enthusiastic about the.
The runway there with a demographic tailwind.
We know we brought on a de novo as last year, which previously that was the high this year, we'll be bringing online we've already set up for for next year as well the bed additions strategy on top of that de Novo strategy I think plays very favorable and our ability to grow this bill.
And take advantage of the opportunities that are out there in the marketplace. So.
Between the continued demand in our ability to go out and add capacity to meet that demand.
I've got a really nice runway ahead of us.
It'll be a little uneven as you saw for instance in this quarter, depending on the comp that you are up against but generally speaking if you smooth it out over time, you'd expect something in the 2.5% to 3% range to come from same store with the balance being contributed by new store.
Awesome. Thanks, guys.
Thank you.
Our next question will come from John Ransom with Raymond James.
John .
Good morning.
So Doug do you you don't you won't like this question.
Yeah, but that's the one I'm getting so I got to ask it. So yeah. The whole long habits process I think as you know kind of at least at this point looks a little disappointing.
So within the bounds of what you can tell us how is it that the vanilla spend.
Ended up being a plan a and you have some type of spin merger sale couldn't have resulted I mean, I think it's around eight five times EBITDA now in the numbers have come down a couple of times that you know so just what can you tell us to say hey, This really was the best option.
Yeah.
The other thing too there weren't forthcoming or we just for tax reasons or other reasons, we decided to go the route we get thank you.
No John it's a very fair question.
And I know the process took a lot longer than most folks had anticipated. Let me tell you. It took a lot longer than we had anticipated at the outset as well and the length of time that the process took what was really a result of two factors. One is we had pretty volatile market conditions that occurred during the course of that process.
Yes, and they shifted a couple of times some of those COVID-19 related and some of those more just generally market oriented.
Other thing is that our board wanted to make sure that we conducted an extremely thorough evaluation and then we looked at every one of those alternatives and you enumerated a number of them to choose the one that was going to generate the best long term value for our shareholders.
And the board is confident in the decision. They made they also recognize that based on prevailing market conditions and just the way that spins work that this wasn't going to be something where the efficacy of the tranche chosen transaction should be judged in a one month or two month or even a six month period, but it will stand the test of time.
And so yes, it looks like in habit is off to a challenging start recall follows. This one they can address their operating results separately, but this is not done yet.
John I'll I'll as Markman, a number of us are shareholders and we continue to have a great deal of confidence in that team added habit. So look forward to future John does that does that address your question sufficiently.
I think that's all you can say so that's I think that's fine now my other question. That's the happier question as well.
Hey, you guys have been bogged down in this process.
Drama a lot of time and it's now now that you're not whereas if we're sitting here a year from now two years from now.
What is different with legacy E C.
Might not otherwise been the case, if you were still wrestling with and habit.
Okay.
Well I think we've articulated here, we're very excited about what the future holds about the opportunity for us to continue to grow and in the.
<unk> business is as you know John it's an area that we know quite well.
We have a team here that's been built to contribute in and develop that growth.
And so I think we're very excited about what the future holds.
I think it just becomes a more focused story, John maybe one that is a bit easier for those on the outside to understand and we'll be able to highlight the great returns that we're getting on invested capital.
The superiority of our clinical results the efficiency of our operating model and maybe really highlights some of the additional capabilities, we're bringing to bear to the benefit of our patients and in.
And the the.
The caregivers.
Who are involved with regard to new technologies and new clinical protocols.
Thanks, so much.
Thank you.
Our next question will come from Peter Chickering with Deutsche Bank.
Hey, good morning, guys. Thanks for taking my questions.
Labor expenses are pretty volatile right now with all the moving pieces here and this may be an exercise in futility.
As a semi our contract labor cost a signing bonus shift bonuses, but.
If we exclude contract labor and exclude signing bonuses and excludes shift bonuses.
The hourly full time employee greats and QQ.
How does that compare sequentially versus the first quarter and where are you still seeing pressure relief in those early rates.
You know we've always.
Kind of interesting because we really began pretty aggressively in Q3 of last year, making market adjustments for the internal ftes to remain competitive.
And so as we move in the back half of the year, we really expect that on that base of internal ftes.
See a pretty normalized level of increase so call it something in the three 5% to 4% range.
Yes.
Because there's just so many moving parts year over year, I guess, if I, just think sequentially <unk> or the average hourly full time employee right is that stable.
Yeah. It's so it was a little bit elevated in the second half because you were anniversarying that yet, but as we move into the second half the comparisons get more favorable and we've really done what we needed to do with regard to market adjustments now youre looking at just a more normalized merit cycle, which is slightly elevated over where it was say.
2021, but not significantly.
Okay, perfect and then just some questions on that on contract Labor you did give the number of Ftes in June I guess any any call it that.
If you can give us on how much that cost you in June or the or the run rate.
I did mentioned the rates in our.
In June so the rate was down to 293000.
In June I don't want to give you a we're not going to give a number on a monthly basis, we don't want to get into that habit and continue to report it on a quarterly basis, yes, sorry two.
Two more quick ones here.
For signing bonuses that realize over time or is that all upfront.
It's all upfront.
Alright, perfect and then the last question is as you track the ROIC.
Certainly in the last 18 months of it that add ons versus say 2017, 2018 do you find that the ROIC that add ons on the new projects as they ramp is identical with someone to where it was sort of previous to 2018. Thanks. So much.
Okay.
Yes.
And it does depend on which vintage youre looking at I will say that one of the things that we're experiencing right now is as we evaluate new projects. We've got elevated construction cost. So the investment is going up and you know right.
Right now our labor costs are elevated.
So that does impact, particularly in the early years of the P&L.
I will say that as a result with in our aggregate pipeline. There had been a couple of projects because it was specifically difficult conditions in a particular market where construction labor costs may be impacted that we've decided to stand down not canceled, but the stand down on a couple of projects. It's been a very limited number.
Out of a total pipeline that is typically comprised of about 50 projects I think we're talking about less than a handful by and large we're able to see is even when we model in the elevated construction cost and assumptions about the trajectory in labor cost, we're still seeing a projected returns that exceed by.
Pretty good margin, our weighted average cost of capital and that's why we're continuing to move forward with the capacity additions and then of course anytime we can add a bed addition to either an existing facility where our recent de novo that just serves to turbocharge the return.
Great. Thanks, so much guys.
Hum.
Thank you.
A reminder, that is star one to ask a question.
Next question will come from Matthew Borsch with BMO capital markets.
Good morning, Matt.
Thank you.
Hi.
Thank you could I just ask about.
Now that you're operating with them with a very strong focus on the inpatient rehab there yet and I realize that ultimately you reached the conclusion that home health was not.
Alright strongly synergistic enough to make it make sense to hold onto that are there. Other areas you might look at that you could see as synergistic that you'd be willing to share and how.
Are you thinking about acquisitions at this stage and if so.
What types of things would you look at.
So you know, Matt we're constantly scanning the landscape and decide if there are any compelling businesses that ought to be added to our portfolio either because there is a gap in our existing model or because the new capability is required to take us to the next level with regard to moving into an adjacent space.
In the provider universe, there's nothing on our radar screen right now that suggests that it would be compelling.
We've already made the decision and have separated out home health and hospice. So the remaining adjacencies in the post acute space would be L tax sniffs and as we've stated before you know we think that.
There's going to be a gradual but and ultimate progression towards some site neutrality with regard to post acute inpatient facilities and we think the best way to prepare for that is to continue to invest in freestanding ers and we say that because even if there is no change in the patient criteria.
And even if the evolution is very slow the demand for inpatient rehabilitation services in this country remains very high and very Underpenetrated.
We can use as a prime or facie estimate of that the fact that if you just look at the CMS 13 eligible discharges coming out of acute care hospitals in the U S on an annual basis.
Less than 15% of those find their way into an earth bag. So theres, a tremendous white space for us to grow into.
Moreover, if we do eventually move towards site neutrality for inpatient post acute it is our belief that the physical construction the clinical expertise and the staffing compliment that exist in the Earth model today are better positioned than either an <unk> or snip.
To adjust to those changing conditions, so that kind of addresses our thoughts on the provider community with regard to other services that we think could either enhance our value proposition or make us a more efficient operator, that's a constant evaluation.
And when we evaluate those we're trying to think about a what does it really do to position us more competitively and D is that something that we need to own or is it something we can replicate internally or buy as a vendor.
So that evaluation will remain open and I can't point to any specific service line right now that we think is a must add on for us.
Okay. Thank you for all that.
Thank you.
Our next question will come from Sarah James with Barclays.
Okay.
Hi, good morning.
Can you help us understand what portion of your contract labor is related to.
Permanent staff that is just on.
Quarantine for testing positive and then as we move into the.
The phases of Covid, we're spread rate is higher but symptoms are lower is there any discussion.
With the C D C or internally around.
Testing frequency and corn.
Right.
So let me take this morning I'll take the first the first portion of your question right now.
Given the current rates.
Rates of Covid.
As we've seen in the marketplace, we're not experiencing and staffing difficulties, where we would be bringing in contract labor to offset corn seed and staff at this point. So it has pretty much neutralized out there in the marketplace versus where it might've been a peak.
Peak periods from last year or even the prior year of that.
And then the second part of your question. There is yes, there is flexibility within the CDC guidelines for a member of our clinical staff, who receives an exposure to COVID-19 to still be able to work provided that they meet certain that they are able to pass the test.
Great.
And then just wanted to circle back on capital deployment I know part of your strategy has always been to.
By property or a build footprints that are larger than you initially needs to be the flexibility to to build out more space can you give us an idea of.
Where you guys are in that process like how many of your facilities have that capacity to see.
Add rooms or ad therapy.
Therapeutic space with an existing footprint.
Yeah. So I would say you know almost without exception every de novo that we have brought on board in the last 10 years still has room for maybe one or two that are exceptions, but still has room for additional capacity growth.
Typically we are buying five to seven acres of useable land to housing de Novo. We're building a single storey facility that is that can be expanded without disruption to the existing capacity. That's there as well it's much more of a mixed bag within our legacy.
Hospitals.
Got a greater variety in terms of the physical construction of those and location and C. O N requirements and so forth, but we remain very confident that an ability to add 100 to 150 beds per annum to the existing base now some of thats going to be a little bit lumpy just based on timing as an example, Marc alluded in.
His comments and the fact that we now think just based on timing of one project has moved from late in Q4 to early in Q1 of next year that we're going to open up 90 beds. This year that means we'll probably be towards the high end of the range next year.
Great. Thank you.
Thank you.
At this time there are no further questions. So I would like to turn the call back over to Mark.
<unk> for any additional or closing remarks.
Thank you if anyone has additional questions. Please call me at 2059705860. Thank you again for joining today's call.
Thank you ladies and gentlemen, this concludes today's conference and we appreciate your participation you may disconnect at any time.
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